In other words, this post could be titled the an angel investors problems with convertible bridge notes.

I recently had coffee with Geoff Entress of Madrona Venture
Capital. We started discussing the woes of being an angel investor in companies
that were financed with bridge notes. I told him that I smelled a blog post . Here it
is...

From an angel investor's perspective, bridge notes are often
too entrepreneur and company friendly. (Remember,
I am an entrepreneur).

The big picture problem with bridge notes

The real problem with bridge notes from the angel investor
perspective is one of timing, risk and reward. The angel invests today and
gives the company capital to create value that ultimately gets priced (valued)
tomorrow. The value of the capital that the angel parts with today and associated risk is
HUGE but under the structure of the bridge note the angel investor is not able
to capture the real value of the capital and risk that is being undertaken. A good metaphor for a bridge note comes from Wimpy and Popeye – the entrepreneur will gladly sell you a bridge note today
and price it for you on Tuesday.

The problem of price uncertainty

The second problem is that the convertible bridge note
structure gives the angel investor too much price uncertainty. In order to invest with confidence, it's much
more useful to know the price of the stock. If the price is good, the angel is more
likely to invest more. If the price is bad, the angel is likely NOT to invest. The uncertainty surrounding the price of the underlying security in
a bridge note makes it difficult to invest with confidence. So, in a weird way the bridge note actually
acts as a deterrent to angel investing (it does to Geoff and I at least). Investing
in start up companies is risky enough, investing using bridge notes makes the investment
game even more like a game of roulette.

The problem of variance and misuse

There's another problem with bridge notes ....there's not a
standard structure and they're often implemented in a way that favors the
company too much. The biggest issue
I've seen is the way in which bridge notes handle the event of conversion if a
Series A round is not achieved. Often, there is no clear provision for this
whatsoever. This is unacceptable as an investor. If the milestone of teh institutional round is not met within a reasonable period of time (i.e. 6 months) then, in my opinion, the note should automatically convert into a preferred security at a set price that is stated in the bridge note.

I'm sure that there are other problems that I'm omitting but I think I hit on the big three problems. More on bridge notes to come. That's it for today.